Saturday, April 13, 2013

Longer Term on Commodities

For commodities bulls, it has been a terrible time since QE3.  What was supposed to be a catalyst for an inflationary explosion higher in real assets, has only led to a chase for yield in dividend paying stocks in a slowing economy.  The main culprit for this is the king of commodities:  crude oil.

Everything in the commodity space is based off of crude oil.  It is the driving force for grains and softs, industrial metals, and by inflationary correlation, precious metals.  Oddly enough, its energy cousin natural gas is one of the least correlated to crude oil.  The reason crude oil drives grain prices is corn, which drives the price of other grains and many of the softs.  Corn requires a lot of energy input to produce, and one of its products, ethanol is used as a gasoline substitute. 

The reason I am writing today about commodities is because of gold.  It broke $1500 with a huge surge of liquidation on Friday.  Those financial analysts who talked about $5000 gold like its a foregone conclusion are buffoons.  Even when I was super bullish on gold in 2011, I thought they were idiots. 

Based on the general view of gold, this downtrend is attributed to the rising stock market and the lack of need for a safe haven.  And of course poor performance.  Well, gold isn't a safe haven.  It went down just like the stock market in fall of 2008.  And safe havens don't regularly spike down 2% in minutes based on stop orders being filled. 

Gold is a play on inflation and investor sentiment.  Obviously, investor sentiment is sour on gold right now, and there has been serious liquidation and reduction in the GLD ETF holdings.  But when investor sentiment improves, so will the price.  Fundamentals aren't really important for gold, it is the most sentiment based major asset.

Right now, gold is trapped in oil's bear market.  Oil is such a lynchpin to the inflation level that its fundamental price weakness has major ramifications for gold.  Oil is affecting gold sentiment.  Right now, oil is facing an intermediate term problem of increased shale oil production, which will last for a few years and peter out, but which is causing a problem now for the oil bulls.  The global economy, in particular China, is not strong enough to increase oil demand, there are constant increases in fuel efficiency, and supply from shale oil and increased natural gas liquids more than makes up for declines in older wells.  Thus, you are seeing crude oil struggle for the past 6 months despite central banks QEing and a rising stock market. 

I was in the camp that gold would be a bubble back in 2011 but I didn't expect shale oil to have such an impact on the oil price.  The oil market just isn't tight enough to move much higher.  Without an explosion higher in crude oil prices, you will need a panic to get gold noticeably higher like with the European debt crisis in August 2011, but those panics are long shots, like rolling snake eyes.  Plus, they don't lead to sustainable moves which cause bubbles. 

On a short term basis, the pessimism is too thick right now on gold, and the market is oversold, so I expect a strong bounce, in conjuction with renewed media attention on the debt ceiling over the coming weeks.

On a long term basis, I just don't see gold, and by extension most other commodities extending its bull market with the headwinds for oil.  I expect a long period of sideways trading for gold, with perhaps a range of $1400 to $1800 for the next few years.  But in the very long term, in the next 10 years, I expect another explosive move higher as the oil market gets tighter and the cumulative effect of a steady increase in money supply takes effect.  Then talks of $5000 gold will not be so outrageous.

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